Market Watch Weekly - April 10, 2015

Published by Dekker Hewett Group on Apr 10, 2015

This week we came across some very interesting and alarming information regarding the drought situation building in the state of California. Now while this may sound not that important, when you consider that California is the largest producer of the vast majority of produce consumed in North America, the impact on food costs leading inflation higher could be significant. When we consider the cost impacts consumers may see on the price of lettuce, avocados, oranges, almonds etc...it could be expected that we see substantial food cost inflation over the coming years.

We view this as a potentially important shift of factors that drive inflation, simply due to the fact that we cannot control the weather. Rising inflation due to strengthening economic conditions can be dealt with via raising interest rates. Rising energy costs are often met with increased production, however there is little we can do to lower temperatures or increase rainfall.

California has already reported that due to existing water shortages, farmers have been uprooting orchards and leaving farmland fallow as there is simply no water available. Additionally, the Governor of California issued an executive order in March for statewide water restrictions where water agencies must reduce water usage by 25%. As the state not only increases the prices of water but also makes less available to farmers, this situation only looks to worsen.

The record low rainfall in combination with the shattering of recorded temperature measurements has lead to the worst drought that California has ever seen. High temperatures have not only lead to very depleted moisture levels in the soil, but current reservoir levels are at only 50% of normal for this time of year and last winter’s snowpack has already melted.

To put the chart below into perspective, over the last twelve months California has seen temperatures 4.5 degrees higher than they were on average for the entire previous century. According to the International Panel on Climate Change, what makes this chart troubling is that the 1,300 scientists that make up this panel are forecasting a rise in temperature between 2.5 and 10 degrees Fahrenheit over the next century, which means that these drought conditions could very well become the norm.

Regarding economic statistics this week, Statistics Canada released its labour force survey for March. In a nutshell, employment increased by 29,000 last month, driven by part-time employment and surprisingly, it was jobs related to natural resources where Canada saw its largest increase in employment, despite weak commodity prices in general.

Within the energy sector, we also saw a large takeover being announced this week with Royal Dutch Shell swallowing BG Group at a significant premium to their market value. What we found to be very interesting was that Royal Dutch Shell is basing the takeover on a long term valuation of Brent Crude Oil of $90 per barrel…well above the most optimistic assumptions used by energy analysts.

What makes us sit up and take notice is that the last time we saw such mega takeover was at the last trough in the energy cycle when BP took over Amaco, and Exxon took over Mobile, fifteen years ago. The Royal Dutch Shell proposed takeover of BG is also important to the BC LNG sector, as it seems to us Shell is making a substantial move to place them at the forefront of the BC LNG industry, one that we are increasingly expecting to see move forward.

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